How To Invest In Bonds
After dabbling in the stock market, you must learn how to invest in bonds. Bonds provide increased portfolio diversification, a steady return in the form of interest payments, and a potentially lucrative investment as the price of the bond fluctuates. Learning how to invest in bonds is easy – researching potential investments and picking winners is more difficult.
- Understand your return requirements and risk tolerance. Bonds can provide a stable source of income or become risky investments with a high rate of default. Generally speaking, the riskier the bond the higher the interest rate (and potential rate of return) – but also the greater the risk of default. To invest in bonds, you must first determine how much risk you are willing to take and how much of a return on your investment you are seeking.
- Determine the type of bonds that fit your risk/return profile. The safest bonds are U.S. Treasury bonds which have the full backing of the United States Government. These bonds provide a very low rate of return but have essential no risk of default. Conversely, junk bonds issued by corporations enjoy a much higher interest rate – but also are at a greater risk of default. Determine whether highly-rated corporate bonds, low rated corporate bonds, U.S. Treasury bonds, or municipal bonds fit your investment objectives best.
- Research potential bond investments. Just like stocks, to invest in bonds an investor must research potential investments. Price fluctuations of bonds are a result of the fiscal soundness of the underlying organization, be it an individual corporation, local government or the federal government. Purchase or look for free third party research of the company/bonds you are interested in. For corporate bonds, read the company’s financial reports and come up with a determination of the fiscal soundness of the company.
- Open a brokerage account. Brokerage accounts must be used to invest in bonds. Unlike the stock market, the majority of the bond market is an over-the-counter (OTC) market. This means that bond purchases can only be made by a broker either over the phone or, in some cases, online. Open up a brokerage account with a brick-and-mortar brokerage house or establish an account online so you can invest in bonds.
- Contact your broker to make a purchase. Contact you broker to make a bond purchase. Realize that bond purchases are not instantaneous (like most stock purchases on an exchange) because the broker must contact several bond dealers to secure the bonds you are interested in. Alternatively, U.S. Treasury bonds can be bought online through the U.S. Treasury.
- Contact a corporation to inquire if they sell bonds directly to individual investors. Some larger corporations sell bonds directly to individual investors. If you are interested in a specific bond issue, contact the investor relations department of that company to determine if they will sell bonds directly to you. This eliminates the fees of brokers and dealers, and eliminates the need for a brokerage account altogether.
- Only invest money you are willing to lose. Unless you decide to invest in U.S. Treasury bonds, there is always some risk of default on your investment. Be prepared to lose your entire portfolio, especially when just starting out.
To invest in bonds make your bond picks strategically, do adequate research, and be willing to adjust your purchases as necessary. Learning to invest in bonds can be a rewarding experience, diversifying your portfolio and potentially increasing your rate of return. Above all else, ensure that the bonds you purchase fit your return requirements and risk assessment.